Indices Tighten On Back Of CDO Hedging

Dealers led tightening on the European iTraxx credit indices last week after a number of firms printed synthetic collateralized debt obligations and turned to the indices to hedge short credit exposure.

Dealers led tightening on the European iTraxx credit indices last week after a number of firms printed synthetic collateralized debt obligations and turned to the indices to hedge short credit exposure. Traders said at least three CDOs were issued and index protection selling on the back of the deals pushed spreads tighter on the iTraxx indices. "Dealers were selling the indices to get broad market exposure," said one trader at a U.K house.

The price of protection on the iTraxx Main tightened to 36 basis points on Thursday from 37 bps the week before. Over the same period, iTraxx HiVol moved to 67 bps from 70 bps and iTraxx Crossover to 282 bps from 290 bps. "There has been noise within the range, even through the range is tight," said one trader, who added five- and seven-year trades were the most popular. Another trader said it is because spreads are so tight that new issuance of structured products is able to affect the market and pull it tighter.

One credit strategist said the CDOs printed last week are evidence the market is rebounding from an unsteady third quarter. "The auto downgrades in May slowed the market by three to four months and then we had summer," he said, adding, "People are now more confident to print and the pipeline is full." He predicted a further uptick in structured products issuance in the coming months.

An official at a European house also cited a lack of clear market trend as the reason index contracts were better bid than single names. "There is no direction in the market and people are trying to second guess what it will be," he said, adding, "The fundamentals say spreads should go wider, but it's hard to know."